Self-Employment

Self-employment is working for yourself rather than as someone's employee. The IRS treats you as self-employed if you carry on a trade or business as a sole proprietor or an independent contractor, if you are a member of a partnership that carries on a trade or business, or if you are otherwise in business for yourself, which includes a part-time business and gig work. The consequences come in three parts. You owe self-employment tax, which is the Social Security tax and Medicare tax an employer would otherwise pay half of; no employer withholds income tax from what you receive, so estimated taxes paid during the year take the place of withholding; and you subtract the genuine costs of the business from what it takes in, so tax attaches to the profit rather than to the receipts.

The everyday word and the statutory terms are not the same thing, and the difference is worth knowing because tax attaches to the statutory ones. Internal Revenue Code Section 1402 never defines "self-employment" at all. It defines net earnings from self-employment as the gross income an individual derives from any trade or business they carry on, less the deductions attributable to that trade or business, plus their distributive share of income or loss from any trade or business carried on by a partnership of which they are a member. It then defines self-employment income as those net earnings with two limits applied: net earnings below $400 for the year do not count at all, and for the Social Security portion nothing counts above the year's contribution and benefit base ($184,500 for 2026), reduced by any wages the individual was already paid. So the everyday word describes a working arrangement, while the statutory terms describe a computed amount, and the amount is what the tax actually reaches.

What makes an activity self-employment in the first place is the trade-or-business test. Section 1402(c) borrows the meaning of "trade or business" from Section 162, the provision governing business expense deductions, so it is the same question that decides whether costs are deductible: whether this is a genuine, continuing, profit-seeking activity rather than a hobby or an isolated job. The section then carves out two things that are not a trade or business for this purpose, the functions of a public office (with a narrow exception for certain fee-based state and local positions) and service performed as an employee. That second exclusion is why identical work can be self-employment for one person and wages for another. What settles it is the working relationship, not the label on the payment.

The $400 floor is easy to misread. It applies to net earnings from self-employment, which Section 1402(a)(12) sets slightly below the business's profit, so the profit figure that trips the threshold is a little over $433 rather than exactly $400. The same figure decides whether Schedule SE has to be filed for the year.

Two items look like business income and sit outside net earnings from self-employment anyway. Rentals from real estate are excluded unless received in the course of a trade or business as a real estate dealer. A limited partner's distributive share is also excluded, other than guaranteed payments for services actually rendered to the partnership.

The sequence is the same every year. Establish that the activity is a trade or business rather than a hobby; total what it took in and subtract the expenses attributable to it, which gives its profit or loss; convert that profit into net earnings from self-employment, a figure Section 1402(a) sets slightly below the profit; then apply the two limits in Section 1402(b). Net earnings under $400 for the year drop out entirely, and the Social Security portion reaches only the room left under the year's ceiling after any wages already paid. What remains is self-employment income, reported on Schedule SE alongside the business result itself.

A hypothetical example. Priya has a salaried job paying $175,000 and a freelance editing business on the side. The business billed $48,000 and had $11,000 of deductible costs (software subscriptions, a contract proofreader, and business mileage), so its profit is $37,000. Her net earnings from self-employment are 92.35% of that, or $34,169.50, because Section 1402(a)(12) allows a deduction equal to half the combined self-employment tax rates before the tax is computed. That is far above $400, so all of it is self-employment income. Her wages have already used up most of the year's Social Security ceiling, so only the room left under it is exposed to the Social Security portion, while the Medicare portion has no ceiling and reaches the full $34,169.50.

Pros

• Genuine business costs come out first, so tax attaches to the profit rather than to the gross receipts.
• Retirement plans built for people without employees, including a solo 401(k), a SEP IRA, and a SIMPLE IRA, allow far larger contributions than an IRA alone.
• You control the timing of income and expenses to a degree an employee cannot, which makes multi-year tax planning possible.
• Health insurance premiums may qualify for the self-employed health insurance deduction, which comes off income directly rather than as an itemized medical expense. It is capped at the earned income the business produced, and it is unavailable for any month you were eligible for a subsidized plan through your own or a spouse's employer.

Cons

• You pay both the employee and the employer halves of Social Security and Medicare tax on your net earnings, where an employee sees only one half come out of their pay.
• Nothing is withheld for you, so estimated taxes are your own responsibility and underpaying carries an interest-like penalty.
• No benefits ride along with the work, so there is no employer retirement match, no employer share of health premiums and no paid leave. Unemployment insurance generally does not reach you either, because the system is built around service performed for an employer, which is why Congress had to create a separate program to pay the self-employed during the pandemic.
• Business income is often irregular, which makes both cash flow and accurate tax estimates harder than a steady paycheck.
• Substantiating every deduction is on you, and the recordkeeping it requires is a real cost of the arrangement.